Competitive Financing Mechanisms: Auctions Used by Federal Agencies

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GAO General Accounting Office
Washington, D.C. 20548
Health, Education, and
Human Services Division
B-28 1997
February 24,1999
The Honorable William F. Goodling
Chairman, Committee on Education
and the Workforce
House of Representatives
The Honorable Howard P. M&eon
Chairman, Subcommittee on Postsecondary
Education, Training, and Lifelong Learning
Committee on Education and the Workforce
House of Representatives
The Honorable Peter Hoekstra
Chairman, Subcommittee on Oversight
and Investigations
Committee on Education and the Workforce
House of Representatives
Subject: Competitive Financing Mechanisms: Auctions Used by Federal Agencies
Students borrowing through the Federal Family Education Loan Program (FFELP) and the
William D. Ford Federal Direct Loan Program (FDLP) pay interest rates that are set by the
Congress.’ The Congress also sets the maximum interest rate that lenders participating in
FFELP can receive. Government costs in the program depend in part on the relationship
between borrowers’ and lenders’ interest rates. In setting these rates, the Congress faces
several tradeoffs. For example, the borrowers’ rate must be low enough that students can
afford to borrow, and the lenders’ rate must be high enough to ensure a reasonable rate of
return to participating lenders. However, if the rate for borrowers is too low or the rate for
lenders is too high, federal costs increase. The difficulty in establishing satisfactory interest
‘For an FFELP loan, a lender, usually from the private sector, provides loan funds, makes and
services the loan, and collects loan repayments; the government guarantees the loan against
default. Under FDLP, in contrast, the government provides funds for loans made to student
borrowers, schools make the loans on behalf of the government, and a contractor services and
collects loan repayments. Since FDLP loans were first made in 1993, FDLP borrowers’ rates
have generally been identical to those for FFELP loans. In academic year 1997-98, federal
student loans made through FFELP totaled about $22 billion and those through FDLP about
$11 billion.
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rates was illustrated by discussions in the past year, during the reauthorization of the Higher
Education Act of 1965 (HEA), over the level at which to set them. The administration
proposed reducing both borrowers’ and lenders’ rates below a level that some members of the
Congress and FFELP lender groups believed would be sufficient to keep lenders in the
program. The reauthorization eventually reduced both rates, but the borrowers’ rate was
reduced by more than the lenders’ rate, and the government currently makes up the difference
to lenders.
In the course of these discussions, some in the administration and the Congress raised the
possibility of establishing an auction or some other type of financial market mechanism to
determine the lenders’ interest rate rather than the Congress setting it. Such a mechanism
could be designed to encourage bidders to compete to offer the lowest cost to students or to
the government, and it could take several forms. For example, the government could auction
the right to make loans to students, or it could auction all or part of the loan portfolio after
students have already taken out their loans. Because auction structures can vary a great deal,
and because of ongoing discussions regarding auctions in FFELP, you asked us to identify
the auctions federal agencies currently use to award rights or sell assets and the ways in
which they differ.
We gathered information on a diverse selection of federal agency auctions from our earlier
reports, other literature on auctions, and intemet searches of government programs. In some
cases, we supplemented our information with interviews with agency officials. While we
made a concerted effort to research multiple sources of information, we cannot be certain we
have identified all such auctions. We have been mandated to do further work in this area,
including analyzing how the student loan industry might or might not be suitable for an
auction, and thus we did not perform such analyses for this report2 We conducted our study
between June 1998 and January 1999 in accordance with generally accepted government
auditing standards.
In summary, we identified 31 auctions that federal agencies use to sell assets such as rights to
conduct certain activities, financial assets, real estate, and consumer goods. We classified 12
of the 31 as auctions for specialized items that are of interest primarily to members of a
particular industry or large investors. Assets sold in these auctions include the right to
provide wireless communications service in a given market, allowances to emit a certain
amount of sulfur dioxide (SO2) into the atmosphere, and Treasury securities. Some of these
auctions sell assets in a single round of bidding while others use multiple rounds, and some
result in a single winner while others result in multiple winners. The 19 other auctions are
for assetsthat can be classified as being of interest to the general public, including individual
homes and consumer goods, such as cars or furniture, seized or deemed surplus by the
government. Some of these auctions use open bidding and others use sealed bidding, but
they have many characteristics in common, such as a single winner for each item auctioned
and a single round of bidding.
2P.L. 105-244 (Oct. 7, 1998), section 801.
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BACKGROUND
Since the inception of FFELP, the government has established interest rates for borrowers
and lenders in the student loan program, with the goal of ensuring students access to higher
education at an affordable price with an adequate profit for lenders. These rates have
generally decreased since then, in part because of policy decisions, but policymakers cannot
be certain how low they can set interest rates--to minimize costs for students and the
government--without endangering lenders’ participation in FFELP. For this reason, some
have raised the idea of using some type of auction, or other market mechanism, to set the
interest rate that lenders receive.
Interest Rates and Government Costs in FFIZLP
The government guarantees student loans made through FFELP--that is, the government
generally reimburses lenders if borrowers default. In addition, the government subsidizes
interest costs for students in two ways. For all FFELP loans, the government sets an interest
rate that is generally below the market rate students would otherwise pay and sets a rate for
lenders to ensure that they receive close to a market interest rate. In addition, for subsidized
FFELP loans, the government pays interest to lenders on behalf of students while they are
attending school or in a grace or deferment period.3 Government costs in the program
depend in part on the relationship between borrowers’ and lenders’ interest rates, a
relationship that has changed throughout the history of the program.
In FFELP, students pay an interest rate established by the Congress, and lenders receive an
interest rate similarly established by the Congress, although the rate may differ from the
borrowers’ rate. Before 1986, borrowers paid a fixed interest rate, but lenders received a
variable rate--the 91-day Treasury bill (T-bill) rate plus a margin above that rate, set at 3.5
percentage points. When borrowers’ interest payments were less than what lenders were
entitled to receive, the government paid lenders the difference, which ‘was substantial in times
of high interest rates. In 1992, legislation changed the borrowers’ rate to a variable rate--the
91-day T-bill plus a 3.1 percentage point margin, subject to a cap of 8.25 percent. The
lenders’ margin over the 91-day T-bill was also equal to 3.1 percentage points in 1992. If the
T-bill rate was low enough that the cap was not in effect, then borrowers paid the same rate
?Stafford loans, which make up the bulk of FFELP loans, can be subsidized (in which case,
the government makes interest payments on behalf of students while they are in school or in a
grace or deferment period) or unsubsidized (in which case the borrower is responsible for all
interest costs). The rates described here are for Stafford loans; terms for consolidation loans
and Parent Loans for Undergraduate Students, the other components of FFELP, differ
somewhat. Under current program rules, a grace period is a 6-month period after a borrower
first leaves school before loan payments first commence. Once the borrower enters
repayment, a deferment is a period during which loan payments are suspended under certain
conditions, such as the borrower’s going on to further education.
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lenders received and the federal government did not incur costs from an interest rate
differential4 In 1995, the lenders’ and borrowers’ margins were reduced to 2.5 percentage
points for periods when a borrower was in school or in a grace or deferment period; the
margin remained 3.1 percentage points during repayment.
The current debate over interest rates and market mechanisms was sparked by a further
reduction in interest rates scheduled for 1998. The interest rate for both borrowers and
lenders was to change to the lo-year Treasury bond rate plus a 1.0 percentage point margin
on July 1, 1998, but temporary legislation was passed to postpone this change.5 This
legislation kept the 91-day T-bill as the basis for borrowers’ and lenders’ rates but reduced
the margin: Borrowers in repayment now pay the 9 l-day T-bill rate plus 2.3 percentage
points, capped at 8.25 percent; lenders receive the 91-day T-bill rate plus 2.8 percentage
points; and the government pays lenders the 0.5 percentage point difference. This rate was
set to expire September 30, 1998, but was extended to June 30,2003, by the reauthorization
of HEA.
Throughout the history of FFELP, and especially over the past year, debate over this formula
has centered on whether lenders’ profits have been excessive--at the expense of college
students, their families, and taxpayers. Lenders have claimed that recent proposals to reduce
the interest rate they receive would force them to end their participation in FFELP. Studies
by the Department of the Treasury, the Congressional Budget Office (CBO), and the
Congressional Research Service (CRS) have reached differing conclusions about the extent to
which lenders could bear a reduction in their interest rate and still continue to earn reasonable
profits6 As a more recent CBO study noted, the federal government lacks information
regarding the costs FFELP lenders incur through their participation.7 Consequently, the
current rate-setting formula may result in some lenders earning higher profits than necessary
to secure their participation. However, if the government were to make a significant cut in
4The government still incurred costs from defaults during these periods. In addition, the
government still incurred interest subsidy costs during these periods for subsidized loans
made through FFELP.
‘This change was scheduled in 1993, upon passage of the bill establishing FDLP. The bill
assumed that direct loans would entirely replace FFELP loans by 1998 and would have made
the interest rate the same as the discount rate used in scoring the loans for budgetary
purposes, consistent with the Federal Credit Reform Act of 1990.
6Department of the Treasury, “The Financial Viability of the Government-Guaranteed
Student Loan Program,” 1998; Congressional Budget Office, “The Profitability of Federally
Guaranteed Student Loans,” March 30, 1998; Congressional Research Service, Student
Loans: What is the Problem With Converting to the lo-Year Interest Rate Benchmark?”
CRS Report 97-733E, July 25, 1997.
7Congressional Budget Office, “Using Auctions to Reduce the Cost of the Federal Family
Education Loan Program,” July 7, 1998.
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the lenders’ rate and some lenders decided not to participate in the program, the supply of
loans might be reduced, perhaps to the point of being insufficient to satisfy the borrowing
desired by students.
These concerns have led some policymakers to suggest using an auction or some other
competitive market mechanism to set the lenders’ interest rate. In an auction, FFELP lenders
or other bidders could signal the lowest possible interest rate they would accept to participate
in the program, They might bid for the right to originate F’FELP loans, with the winner or
winners being those who offer to do so at the lowest rate. Alternatively, they might bid for
loans that have already been originated, with the winner or winners being those willing to
accept the lowest subsidies. In either case, because many lenders could be bidding, this
competition might better ensure that the most efficient lenders would win a role in the student
loan market. Proponents of auctions say that they can generate increased revenue for the
government, or a reduction in spendin g, compared with the current system in which the
government determines prices in the absence of market information. Opponents believe that
certain institutional features of the student loan market make using an auction unsuitable for
the program.
General Characteristics of Auctions
Designers of an auction must make choices about certain of its characteristics. They include
such basic choices as what types of assets will be auctioned--for example, the right to make
loans or loans that have already been made--and whether they are to be auctioned
individually or in groups. Other characteristics include how bidders will place bids on those
assets, how winners are to be determined, and what price a winner will pay. One familiar
auction is an “open outcry,” in which bidders call out prices that increase as the bidding
progresses until no one is willing to place a higher bid. Assets are auctioned individually,
and the last bidder wins the asset and pays the price bid. This is an “open” auction because
each bidder knows what others are bidding (and the identity of the other bidders) and a “first-
price” auction because the price paid is the price bid. One variation on this model is a
“sealed-bid” auction, in which bidders submit their bids without knowing what others are
bidding. Another variation is a “second-price” auction, in which the highest bidder wins but
pays the second-highest price bid.*
*A second-price auction can, under certain circumstances, generate more revenue for the
seller because bidders are more Iikely to bid their true valuation of the object. In deciding
how high to bid, bidders try to avoid the “winner’s curse,” which arises because by definition
the winning bidder has valued an object more highly than other bidders and, perhaps,
overvalued it. In a first-price auction, bidders thus shade their bids downward from their
valuation of the object, because they do not want to win at too high a price. In a second-price
auction, however, a winning bidder pays only the next highest valuation of the object, a
valuation at least one other bidder has placed on the object.
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Other auctions sell multiple items--either identical or different items--simultaneously.
Bidders might bid on individual items or on groups of items, usually through a sealed bid. If
the items are grouped for collective bidding, either the auctioneer or a bidder might define
how the items are grouped. As with a single-item auction, the pricing method can vary. If all
winning bidders pay the amount they bid, the auction exhibits “discriminatory pricing”
because different bidders might pay different amounts for identical items. If all bidders pay a
common price, typically the lowest winning bid, then the auction is a “uniform-price”
auction.
Auctions may differ in these respects, but they are generally used in order to maximize the
revenue generated by selling assets. If the seller sets a price for an asset and sells it at that
price, the seller will not know whether the asset might have sold at a higher price. With
many bidders, if an asset is about to sell at too low a price, presumably someone will bid
slightly higher than the last bid to secure it. Furthermore, this will continue until a bid is
placed that is higher than the valuation all other bidders place on the asset, which means it
sells for as high a price as possible.
The seller will not realize the optimal price if bidders can collude when placing bids. In
some circumstances, bidders acting together can win an asset while paying a lower price than
one winner would have paid had all bidders bid competitively. They then either split the
asset or make payments among themselves such that all end up better off than they might
have after competitive bidding. Thus, avoiding the possibility of collusion is an important
consideration in designing an auction.’ This may be more important in repeated auctions,
when the same bidders may be competing with one another over a period of time, than in
one-time auctions.
AUCTIONS USED BY THE FEDERAL GOVERNMENT AND HOW THEY DIFFER
We identified 3 1 auctions the federal government uses. These auctions vary by how agencies
group assets for bidding, how many winners result, how bids are made, how many bidding
rounds take place, and certain characteristics that may restrict or encourage participation. We
have classified the auctions into two categories: those for rights or financial assets and those
for real estate or consumer goods.
Auctions for Rights or Financial Assets
Of the 31 auctions, 12 are for rights or financial assets, and they tend to be of interest to a
targeted population and differ greatly one from another. These auctions are relatively
‘Overt collusion may involve direct communication and agreement among bidders and may
be illegal. In other cases, bidders might act in a manner that has economic consequences
similar to overt collusion but without the attendant direct communication, and thus the action
may not be illegal.
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complex, and their characteristics are specifically tailored for the assets. Table 1 lists these
auctions and some of their characteristics. For more detail on each of these 12 auctions, see
the enclosure.
GAO/HEHS-99-57R Federal Auctions
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Table 1: Summary of Features of Federal Auctions for Rights or Financial Assets
-
Number of winners
Single winner Multiple
1 Type of bidding
Open Sealed
T Number of rounds
of biddir “s
One Multiple
Restrictive
Minimum
Agency Item auctioned for each unique winners for reserve bid
asset identical assets
Agriculture: Farm Subsidies for land bJ d d
S&ice Agency reserved through the
Conservation Reserve
Program
Agriculture: Food and Right to provide infant
Nutrition Service formula for Special
Supplemental Nutrition
Program for Women,
Infants and Children
Agriculture: Foreign Subsidies to export goods
Agricultural Servicea through the Export
Enhancement and Dairy
Export Incentive
Programs
4griculture: Forest Right to cut timber
Service”
Energy’ Right to extract petroleum d d
in Elk Hills Naval
1 Petroleum Reserve
Environmental 1 Allowances to emit sulfur
Protection Agency dioxide
zederal Right to provide wireless
Zommunications communications services
Zommissior+
Health and Human Right to originate loans
Service? through the Health
Education Assistance
Joan program
-Iousing and Urban Defaulted mortgages J I/
Ievelopment: Federal
jousing
ddministration’ I
8 GAO/HEHS-99-57R
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Number of winners Type of bidding Number of rounds Restrictive
of bidding
Single winner Multiple Open Sealed One Multiple Minimum
Agency Item auctioned for each unique winners for reserve bid
asset identical assets
~ Interior: Bureau of Right to cut timber 4 r/ d d d (/
Land Managementb
Interior: Minerals Right to extract oil, gas, d d d 4
Management Service and sulfur from the Outer
Continental Shelf
Treasury: Bureau of Bills, notes, bonds d (/ d d
the Public Debt
Note: This table omits an auction used by the Resolution Trust Corporation, which no longer
auctioned planned by the Small Business Administration, to begin in 1999, both for defaulted
aWe describe agency’s two programs together because they operate in the same way.
bDepending on the sale, agency uses both open-outcry and sealed-bid auctions. If an open-outcry
may be preceded by the submission of sealed bids. Thus, some sales involve two bidding rounds.
‘This was a one-time competitive negotiated sale with many elements of an auction. While it
multiple bidders could win, in fact a single bidder won all assets.
‘Bidders submit sealed bids, but because bidders know what the high bid is in each market at
bidding round, and have the opportunity to raise any bid, this auction has elements of an open-outcry
eConsideration for noncompetitive bidders in first year of auction only,
‘Agency sometimes institutes a second bidding round.
9 GAO/HEHS-99-57R
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The 12 auctions that sell rights or financial assets are typically of interest to a small set of
bidders and have characteristics tailored to the assetsbeing auctioned. Federal agencies
auction the right to originate medical students’ loans, provide wireless communications
services, emit certain amounts of SO2, and receive subsidies for reserving land from farm
production. These auctions tend to be of interest to members of a particular industry--for
example, lenders who might already participate in student loan programs,
telecommunications providers, businesses that produce SO2 in their operations, or farmers
considering how much to produce in a given year. Financial assetsthat are auctioned include
Treasury securities and pools of defaulted mortgages, and these auctions generally induce
participation from a narrow group, such as large investors.
While the 12 auctions have some common factors, other characteristics vary widely. Some
auctions result in individuals winning specific assets, while others, such as auctions for SO:!
allowances and Treasury securities, sell identical assets to multiple winners. Some agencies,
such as the Federal Housing Administration in its loan auctions, group assets for bidding, and
how the assets are grouped could affect bidding practices. In the auction for the right to
provide wireless communications services, nonidentical assets--the right to provide services
for large metropolitan areas and rural areas--are auctioned simultaneously. All these auctions
use some form of sealed bid, although several incorporate aspects of open bidding as well.
Some auctions incorporate mechanisms designed to encourage small bidders to participate,
but others set minimum bids or require deposits to be made before the auction, which might
discourage participation by small bidders.
Auctions for Real Estate or Consumer Goods
The 19 other auctions are for real estate or consumer goods and are of interest to a more
general population. These auctions have more uniform characteristics, although they differ in
that some use open bids and others use sealed bids. Table 2 surmnarizes the features of these
19 auctions.
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Table 2: Federal Auctions for Real Estate or Consumer Goods
-
T Number of winners
Single winner Multiple
Type of bidding
Open
Number of rounds
of bidding
Multiple
for each winners for
Agency Item auctioned unique asset I identical assets I
Agriculture Agency surplus items
Defense: Army Corps of Housing owned by army
Engineers personnel who were transferred
and unable to sell on their own
Defense: Defense Agency surplus items
Reutilization and
Marketing Service
Energy Agency surplus items
Federal Deposit Defaulted properties for which
Insurance Corporation agency held or guaranteed loan
General Services Both agency surplus items and
Administration surplus from other agencies
Defaulted properties for which /
~
-4----F
Interior: Bureau of Land Federal land deemed unneeded
Management
Justice: U.S. Marshals’ Property seized in use for, or as
Service proceeds of, illegal activity
-
11 GAO/IiEHS-99-57R
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Number of winners Type of bidding Number of
of bidding
Single winner Multiple Open Seated One Multiple
for each winners for
Agency Item auctioned unique asset identical assets
National Aeronautics Agency surplus items d r/ d r’
and Space
Administration
Small Business Defaulted properties for which d r/ v ef
Administration agency held or guaranteed loan
TennesseeValley Agency surplus items d J c,
Authority
Treasury: Bureau of Property seized in use for, or as d d r’
Alcohol, Tobacco, and proceeds of, illegal activity
Firearms
Treasury: Customs Property seized in use for, or as 4 d r/
Service proceeds of, illegal activity
Treasury: Internal Property seized in use for, or as d d (/
Revenue Service proceeds of, illegal activity
Treasury: Secret Service Property seized in use for, or as d r/ (/
proceeds of, illegal activity
United States Postal Items damaged or lost in mail (/ d J d
Service
Veterans Affairs Defaulted properties for which
agency held or guaranteed loan
12 GAO/HEHS-9947R
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These 19 auctions have many characteristics in common, such as a single winner for each
item auctioned and a single round of bidding. The sources for real estate range from
properties for which borrowers defaulted on a federally held mortgage to excess public lands
to housing being sold by army personnel transferring to a different location. Consumer goods
that are auctioned include surplus items that an agency no longer needs--such as computers,
furniture, or vehicles--but can also be items that the government seized because they were
used for illegal purposes. For example, Treasury auctions items seized by four of its
agencies: the Bureau of Alcohol, Tobacco, and Firearms; the Customs Service; the Internal
Revenue Service; and the Secret Service. Agencies publicize these auctions by various
methods, including the intemet, newspaper advertisements, and advance mailings to bidders
who have signed up to receive such information. Most auctions are open to anyone who
wants to bid, although some agencies place age restrictions on bidders or do not allow agency
employees to participate. Items generally are auctioned individually, with one bidder
winning each item after a single round of biddin g. The auctions may be conducted as sealed-
bid or open-outcry auctions, and some agencies use both methods, depending on the
particular items being auctioned at a given time.
AGENCY COMMENTS
We discussed our findings with program-level staff from the Office of Student Financial
Assistance Programs, Department of Education, who offered several technical comments that
we incorporated as appropriate. We also sent relevant portions of a draft of this letter to
program-level staff in each agency who work with the 12 auctions that we discuss in table 1
and the enclosure. We incorporated comments they made regarding our descriptions of how
the auctions operate.
We are sending copies of this letter to the Secretary of Education, appropriate congressional
committees, and others who are interested. If you or your staffs have any questions or wish
to discuss this letter further, please contact me or Jay Eglin, Assistant Director, at (202) 5 12-
7014. Major contributors include James W. Spaulding and Shimon Sarraf.
Carlotta C. Joyner
Director, Education and
Employment Issues
Enclosure
13 GAOMEHS-99-57R Federal Auctions
ENCLOSURE ENCLOSURE
SUMMARIES OF FEDERAL GOVERNMENT AUCTIONS FOR RIGHTS OR
FINANCIAL ASSETS
This enclosure describes 12 federal auctions for the right to undertake certain activities or for
financial assets.
AGRICULTURE, FARM SERVICE AGENCY: CONSERVATION RESERVE
PROGRAM
Since 1986, the Conservation Reserve Program (CRP) has provided rental payments to
farmers and ranchers to remove agricultural land from production for 10 to 15 years, with the
ultimate goal being the prevention of soil erosion, the improvement of air and water quality,
and the establishment or preservation of wildlife habitats. Bid evaluation commences with
farmers and ranchers requesting rental payments through sealed bids for specific plots of
land. The bids may also include steps they will take to plant crops to help preserve soil or
provide wildlife cover. The Department of Agriculture (USDA) compares each rental request
bid to soil-specific maximum rates it has developed and automatically rejects all requests
above the price ceiling. It then evaluates the remaining bids on the basis of an environmental
benefits index, which, in addition to cost, incorporates soil erosion benefits, wildlife cover,
water quality improvement, and three other weighted index components. Farmers and
ranchers whose bids meet a predetermined standard, as shown by the index, are enrolled in
the program, and USDA pays them an annual rent in exchange for retiring the land from
production.
AGRICULTURE, FOOD AND NUTRITION SERVICE: WOMEN, INFANTS AND
CHILDREN INFANT FORMULA REBATES
The Special Supplemental Nutrition Program for Women, Infants and Children (WIC)
provides federal grants to the states for food, including infant formula, for infants and young
children, as well as pregnant, postpartum, and nursing women. Typically, participants
receive benefits in the form of vouchers that they redeem at authorized retail vendors to
obtain food at no cost to the participants. Then, on the basis of the redeemed vouchers, the
state WIC agencies reimburse the retail vendors for the food sold to the WIC participants.
In 1989, WIC state agencies, with few exceptions, were required by law to implement a
competitive bidding system for the procurement of infant formula (or an alternative method
of cost containment that yields savings at least equal to those under a competitive bidding
system). Most of the state programs award a rebate contract to a manufacturer for the
exclusive right to sell its infant formula to WIC participants.” Infant formula manufacturers
“Some groups of states have jointly contracted for a sole-source provider of infant formula,
so the geographic area covered by some contracts may be larger than a single state.
14 GAOMEHS-99-57R Federal Auctions
ENCLOSURE ENCLOSURE
submit sealed bids, and a state awards a sole-source contract to the firm offering the lowest
net price--wholesale price minus rebate. The winning manufacturer then has the right to
provide infant formula in that state for the WIC program. The manufacturer is billed by the
state’s WIC agency for rebates on all infant formula that WIC participants purchase with
vouchers at authorized retail outlets.
AGRICULTURE, FOREIGN AGRICULTURAL SERVICE: EXPORT ENHANCEMENT
AND DAIRY EXPORT INCENTIVE PROGRAMS
Begun in the mid-1980s the Export Enhancement and Dairy Export Incentive Programs are
designed to strengthen U.S. export competitiveness in foreign subsidized markets. In both
programs, USDA pays subsidies, called bonuses, allowing exporters to sell agricultural
products in targeted countries at below-cost prices. USDA establishes quantity and budget
outlay limits for each commodity and country, which creates a quasi-competitive
environment for the subsidies. Once exporters fulfill certain requirements and become
eligible to participate, it is their responsibility to contact prospective buyers in eligible
countries and negotiate a deal. After a sale has been negotiated, a prospective exporter
submits a bid to USDA that includes the quantity, the negotiated price, and the requested
bonus, on a per unit basis, that would allow the sale to take place at the negotiated price.
USDA reviews each bid for the competitiveness of the price and the bonus requested and also
compares it with offers from other exporters. USDA rejects bids with too low a price or too
high a bonus, based on prior USDA market research. In some circumstances, USDA ranks
acceptable bids by their requested bonus amounts and makes awards in ascending order of
requested bonus until the quantity is filled, but this method is used less frequently now than
in the past. Exporters are notified of accepted bids the following business day. If all bids are
rejected, a new round of bidding may take place.
AGRICULTURE, FOREST SERVICE: TIMBER SALES
Forest Service auctions for the right to cut timber on a specific tract of land use both a sealed
and an open bidding system. Bidders are told the minimum price--the Forest Service’s
minimum estimated value for a given tract--and volume of each species on the tract. In some
sales, bidders submit sealed bids and a bid bond, and the high bidder wins the right to harvest
the tract. In other sales, bidders submit initial bids, and the Forest Service then conducts an
oral auction open to those who submitted bids at least equal to the minimum price. Bids may
be based on total sale value or may consist of smaller subbids, made on a per unit basis, for
each timber species found on the tract. Despite the use of these component bids, the tracts
are indivisible: One winner is declared for each tract of land after the Forest Service
evaluates bids and calculates total bid amounts. Some sales provide for preferential awards
to small businesses.
Winners provide some form of advance deposit but do not pay for the timber until it is
harvested and sent off the tract, and they are obligated to harvest the entire tract and pay for
all the trees. In some cases, they pay the amount they bid, while in other cases, the contract
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ENCLOSURE ENCLOSURE
provides for adjustments because of changed market conditions. Finally, for some sales,
Forest Service personnel measure the volume by species while the harvest is being conducted
and base the sales price on these measurements, while in other sales the price paid is based on
the measurement of the timber before the harvest.
ENERGY: ELK HILLS NAVAL PETROLEUM RESERVE
The Department of Energy (DOE) sold the U.S. government’s interest in the Elk Hills Naval
Petroleum Reserve to Occidental of Elk Hills for $3.65 billion in 1997, after conducting a
competitive negotiated sales process similar to a sealed-bid auction. DOE offered for sale
two types of interests in the Reserve: 1 “operating” working interest, representing 74 percent
of the government’s interest, and 13 “nonoperating” working interests, each representing a 2-
percent segment. The nonoperating interests were meant to allow bidders the opportunity to
bid on smaller portions and increase the universe of potential bidders and maximize
government revenues. On the basis of five valuation assessments,DOE established a
minimum acceptable price for the government’s interests. Qualified bidders, those with a
tangible net worth of at least $10 million, could submit multiple offers for individual
segments or bundles of segments. DOE received 22 bids from 15 bidders. After providing all
bidders who exceeded the minimum acceptable price the opportunity to provide a “best and
final” offer, DOE determined that Occidental’s offer for all interests in the reserve exceeded
all other bid combinations. DOE proceeded to negotiate the terms of the final agreement with
Occidental.
ENVIRONMENTAL PROTECTION AGENCY: SULFUR DIOXIDE ALLOWANCES
The 1990 amendments to title IV of the Clean Air Act mandated that the Environmental
Protection Agency (EPA) hold or sponsor an annual auction that provides an opportunity for
electric utilities to acquire additional pollution rights, or allowances, as part of the
government’s acid rain reduction program. EPA delegates to the Chicago Board of Trade
(CBOT) the conduct of an auction for sulfur dioxide (SO2) allowances using a single-round
sealed-bid design. Every year, polluters receive a specific number of allowances, each
granting the right to emit one ton of SO2. Without acquiring additional allowances, each
polluter would be fined for each ton of SO2 it emitted beyond its initial allocation. This fine
was initially set at $2,000 and has been indexed to inflation, compared with a clearing price
of $115 per ton in the 1998 auction.
EPA’s auction sells both spot and advance SO2 allowances. Spot allowances can be used
during the current year or any year thereafter, while advance allowances can be used only for
compliance purposes beginning 7 years from the sale date. Bidders send sealed bids
containing the number of spot and advance allowances to be purchased at specific prices to
CBOT with a certified check or letter of credit for the total bid cost. CBOT designates
winning bids on the basis of highest bidding price until all allowances have been sold or the
number of bids is exhausted. EPA may not set any minimum price for allowances. In this
discriminatory-price auction, winning bidders pay the amount they bid, meaning that the
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ENCLOSURE ENCLOSURE
highest bidders pay more than other winning bidders do for the same commodity.
Allowances can also be traded privately throughout the year.
FEDERAL COMMUNICATIONS COMMISSION: ELECTROMAGNETIC SPECTRUM
LICENSES FOR WIRELESS COMMUNICATIONS
The Federal Communications Commission (FCC) has conducted 18 auctions for licenses to
provide various types of wireless communications services, including broadband Personal
Communication Service, Digital Broadcast Service, and Local Multipoint Distribution
Service (LMDS). Some of these auctions have been conducted for one or two nationwide
licenses, but many have been for hundreds of licenses to serve particular markets, defined
geographically. In these auctions, FCC uses a multiple-round simultaneous design, and
bidders may choose to bid on one or many licenses during the auction.
For a given auction, all prospective bidders submit an application notifying FCC of their
interest in bidding on certain licenses. After FCC has reviewed and approved the initial
applications, bidders make refundable deposits to purchase a sufficient amount of “bidding
units” to ensure their eligibility to bid on the licenses they desire. Each license is tied to a
certain number of bidding units, with licenses for larger markets generally being assigned
more bidding units. A bidder’s maximum eligibility, defined by the number of bidding units
it holds, limits not the dollar amount of actual bids placed but only the total number of
bidding units bid on during any single round.
FCC uses an Automated Auction System in order to process bids. Once bidders purchase the
appropriate computer software, they can send bids through a private and secure wide area
network. At the end of the first bidding round, all bidders learn the maximum bid for each
license. They can then increase bids for any license they wish, subject to their eligibility
level, in the second round. Bidding continues round by round, until a round generates no new
bids. Several FCC auctions have entailed more than 150 rounds.
To ensure a fair return to the government for all licenses, FCC establishes minimum opening
bids, which vary by license: Licenses for small and medium-sized markets generally have
lower minimum opening bids than those for large markets. Bidding credits may be used to
promote equity among bidders. For example, in the 1998 LMDS auction, discounts of 45
percent were given to bidders with annual gross revenues of $15 million or less, 35 percent to
bidders with revenues of $15 million to $40 million, and 25 percent to bidders with revenues
of $40 million to $75 million.
HEALTH AND HUMAN SERVICES: HEALTH EDUCATION ASSISTANCE LOAN
ORIGINATIONS
Since 1992, the Department of Health and Human Services (HHS) has used a single-round,
sealed-bid auction to assign loan origination rights to lenders with the lowest rates for
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ENCLOSURE ENCLOSURE
students in the health professions. Within the Health Education Assistance Loan (HEAL)
program’s auction, lenders win the right to originate loans with a government guarantee of
repayment, also known as “insurance authority.” HEAL loans are made to students in 11
professional health disciplines, each with a particular insurance authority allotment. Two
disciplines are categorized as “medical,” the others as “other.” Lenders bid simultaneously by
these categories and disciplines. Lenders can bid for a portion of a discipline--for example,
for only a particular school or state.
In a given year’s auction, participants submit a sealed bid to HHS consisting of an interest
rate during a student’s in-school, grace, deferment, and repayment periods; the volume of
loans they are interested in providing; their interest capitalization policy; and the market they
are bidding in, whether specific disciplines or states. HHS evaluates bids assuming each loan
recipient will spend 1 year in school, 9 months in grace, 3 years in deferment (for the medical
disciplines), and 25 years in repayment. With this framework, HHS estimates how much a
$10,000 loan would cost a student over the life of the loan. HHS ranks lenders’ costs from
low to high and then groups bidders into “bands” consisting of bidders with similar costs. For
example, in fiscal year 1997-98, all lenders bidding within $750 of the lowest bid were
placed in the first, or winning, band, and others were placed in the second, or nonwinning,
band.
In order to diversify loan originators, HHS allocates loan volume equally among winning
bidders. For example, if five lenders win, each gets 20 percent of the total volume or the
amount it bid on, whichever is less. Because this is a discriminatory-price auction, winning
lenders must offer the terms they bid (or offer lower cost terms) and cannot originate loans at
another winner’s higher rate. If one winning lender originates almost all its allocated amount
while another is well below its limit, HHS reallocates additional authority from a low lender
to the one nearing its ceiling, thus ensuring competition even after the auction concludes.
However, if the lowest-cost bidder is well below all other bidders, HHS might award all
lending authority to this single bidder.
During the HEAL program’s first year, 20 percent of the loans were set aside for nonwinning
bidders. This facilitated a transition out of the program and allowed for easier future
participation by these lenders. Minimum bid and auction deposit mechanisms are not used in
this auction.
HOUSING AND URBAN DEVELOPMENT, FEDERAL HOUSING ADMINISTRATION:
DEFAULTED MORTGAGES
In 1994, the Federal Housing Administration (FHA) began a program to sell mortgages it
held on both single-family and multifamily homes through a competitive auction, primarily
through a sealed-bid design. At the time, FHA owned almost 2,400 multifamily mortgages
with an approximate unpaid principal balance of $7 billion, in addition to 90,000 single-
family mortgages. FHA had insured these mortgages, and most of them came into FHA’s
portfolio through default. Recent movements to streamline the federal government and
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ENCLOSURE ENCLOSURE
FHA’s inability to effectively service and monitor such a large portfolio provided some of the
impetus for these sales.
FHA mortgages are grouped for sale by performance and geographic characteristics. For
example, in 1996, FIIA grouped 16,500 residential, single-family mortgage loans into 750
mortgage loan blocks of approximately $1 million on the basis of performance and then, for
similarly performing loans, by geography. Investors could bid on individual mortgage blocks
or create their own mortgage pools by making their own combination of mortgage blocks.
One bidder might make a single bid on a particular mortgage block, while another bidder
might include that block with others and make a pooled bid. No bidder could make more
than ten pooled bids.
In order to maximize proceeds for taxpayers and to provide a level playing field for large and
small investors, FHA uses a computer program to determine the best available bid
combination. Since bidders can combine mortgage blocks into pools of their choosing, the
potential number of combinations is very large, and the computer program must account for
all combinations that have been bid.
FHA requires bidders to submit a deposit--for example, in the 1996 single-family mortgage
sale, bidders had to submit 10 percent of the bid price, in the case of an individual bid, or 10
percent of the highest bid price among a bidder’s multiple bids. Bids are expressed as a
percentage of the pool’s aggregate unpaid principal balance. FHA reserves the right to
conduct a “best and final” round for the top 5 percent of bidders or to use a lottery if there is
still more than one successful bidder after the “best and final” round.
INTERIOR, BUREAU OF LAND MANAGEMENT: TIMBER SALES
The Bureau of Land Management (BLM) auctions timber in a manner similar to the Forest
Service. Most BLM timber sales take place in western Oregon, although BLM timber sales
also take place in the 11 other western states that have BLM-administered land. For a given
timber sale, BLM calculates a minimum bid from an estimate of the number of trees of each
species and their average size. The estimated total volume in hundred cubic feet (ccf) is
multiplied by the appraised price per ccf, and this product is published as the minimum bid.
Most auctions begin with sealed bids and then proceed to an oral auction, open to those
whose sealed bids are at least as high as the minimum bid and who have submitted the
required deposit with their bids. If no bids are submitted at the oral auction, the sale may be
conducted with sealed bids, but this does not occur frequently. As the Forest Service does,
BLM evaluates bids on the basis of their total dollar amounts, regardless of subbids on
individual species. BLM may also publish rules regarding how a particular plot is to be
logged, which might include required construction or maintenance of roads, the time of year
that logging is to occur, and methods to be used in logging. In some sales, BLM sets aside a
portion of the overall volume for preferential award to small businesses that meet certain
criteria.
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ENCLOSURE ENCLOSURE
INTERIOR, MINERALS MANAGEMENT SERVICE: MINERAL SALES ON THE
OUTER CONTINENTAL SHELF
The Minerals Management Service (MMS) issues leases for submerged Outer Continental
Shelf lands for the purpose of mining oil, gas, and sulfur deposits. Individuals and companies
seeking to extract the minerals submit bids for leasing rights to MMS. The bids contain
“bonuses” to be paid the government for the lease of specific areas, and bidders also submit
deposits for the amount they bid. A bid represents a contractual obligation to pay a fee in
return for the government’s awarding the rights to explore and possibly develop the minerals
on the leased land. Only one round of bidding takes place. While a minimum bid is set,
MMS also estimates the value of the extraction rights after the auction, to ensure that the
winning bidder bids at least this value. For tracts for which MMS believes good information
is available to only a few potential bidders, and for those for which it receives an insufficient
number of competitive bids, MMS estimates the value of the extraction rights and uses this
measure to set the reservation price. For tracts that MMS deems have been bid
competitively, MMS relies on market measures to ensure the receipt of fair value. The
winner pays annual rent for the land, in addition to royalties on the gross value of subsequent
mineral production. In some cases, payment of royalties is suspended until production
reaches a certain level. Proceeds from the leases are sent to accounts with Treasury, such as
the Land and Water Conservation Fund or the Historic Preservation Fund, and in some cases
to states whose coastal borders are adjacent to the leases.
TREASURY, BUREAU OF THE PUBLIC DEBT: BILLS, NOTES, AND BONDS
Treasury conducts auctions for each of the three types of marketable securities--bills, notes,
and bonds.” The first Treasury auction took place in 1929. In 1947, noncompetitive bidding
was introduced, and in 1998, the format for awarding most securities was changed from a
discriminatory-price to a uniform-price auction.i2
Treasury security auctions incorporate both competitive and noncompetitive bidding.
Competitive bidders actually set the yield through their bids. They include money market
banks, dealers, and other institutional investors who buy large quantities of government
securities. Noncompetitive bidders, who agree to pay the weighted average of the accepted
competitive bids, are usually individuals. Before competitive bidders receive any securities,
Treasury sets aside amounts requested by noncompetitive bidders.
“A Treasury bill has a term of 1 year or less, a note has a I- to lo-year term, and a bond has
a term of more than 10 years.
12Treasury first conducted uniform-price auctions in 1992, for sales of 2- and 5-year notes; it
has used uniform-price auctions for inflation-indexed securities since January 1997. All
other securities changed to the uniform-price method in 1998.
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ENCLOSURE ENCLOSURE
Competitive bidders submit a demand schedule for the security being auctioned, consisting
both a yield and a desired volume to be purchased at that yield.” Treasury ranks the bids it
receives from the lowest to highest yield and accepts bids until the cumulative bid volume
equals the total volume offered. Before 1998, in most Treasury auctions, successful bidders
received the yield that they bid, so that winning bidders in an auction might receive different
yields. With the change from a discriminatory-price to a uniform-price auction, bids are still
ranked from the lowest to highest yield, but all successful bidders receive the highest
accepted yield rather than the yield they bid. All bidders in Treasury auctions may bid
without a deposit, although a payment mechanism must be in place with each bidder’s
Federal Reserve bank. Treasury has established a minimum bid of $1,000 for all securities.
(104937)
13For auctions of bills, participants bid the desired discount rate rather than the desired yield.
21 GAOKHEHS-99-57R Federal Auctions
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